What happens when a note seller backs out of your deal? Anyone who has been a note buyer for long has lived through it, and most of the remedies that come to mind cost more than they recover.
How a seller back-out usually unfolds
The scenario goes like this. You get a frantic call asking for a bid on a note. You give the bid, and the note seller signs up with you. The seller calls you often, wanting to know when they will get their money.
Then they stop calling. Then they won’t return your calls. Finally, you find out from a third party that the note is being sold to someone else. Or, even worse, the deal mysteriously evaporates and you never learn what happened.
It’s just part of the note business. The first time it happens, you feel a sense of moral outrage that someone would offer to sell you a note, back out and not even tell you. You think of the time and effort you put into due diligence and writing up the transaction. You think of the lost interest on the cash you set aside to buy the note. You want justice. So what are your options?
Contacting the seller who backed out
First, try to contact the seller and appeal to their sense of ethics, or tell them you may take court action. Sometimes the seller will agree to pay you something for your trouble.
However, most note sellers, once they have backed out, don’t want to confront the problem. They won’t communicate with you, and they won’t pay you.
Going to court and what it really costs
You can take the case to court if you have a signed preliminary agreement with the note seller, and if it was written with “teeth” in it. Without a written preliminary agreement, you would have a hard time getting into court at all.
Assuming you have one, its teeth may take several forms:
- A specific performance clause, forcing the seller to complete the sale. If the seller has already sold the note to someone else (usually the payor), it may be too late.
- A penalty clause, which is more likely to work. A court could award you a penalty payment from the seller if the sale fails for any reason.
- A claim for damages against the seller, in an amount the court decides.
Each remedy has its merits and problems, and each assumes your preliminary agreement is written so a court can rule in your favor. A sloppy or poorly conceived agreement can defeat your own purposes and the court’s power to give you relief. If your agreement left out something important, the court can’t fix it for you. On the other hand, if you pack it with self-serving clauses, the court may decide your document isn’t fair, and you may not win.
The seller will defend too
Even with the best written assurances, you will still have back-outs. If you go to court, you must bring the strongest possible case. Remember that the seller will do the same and may present brilliant defenses. Sellers may argue that they received nothing of value from you and shouldn’t have to pay anything. They may argue that your price was below market, or that you asked for too much private information.
You may find yourself telling the judge that the seller cheated you because they didn’t want to lose money by accepting your discounted price. There is a certain lack of dignity in that argument, and consumer-friendly courts may see you as the one taking advantage of the seller.
Winning doesn’t mean collecting
Even if you win, a judgment is only as good as your ability to enforce it. If there are no assets to attach, no bank funds to freeze and no wages to garnish, your judgment is a hollow victory. You still don’t have the money, but you do have legal bills to pay, plus the lost time and frustration.
Feeling cheated doesn’t mean the court will side with you. That old cliché, that no one wins in court except the lawyers, is usually true.
Recording your agreement and how it backfires
Another approach is to record your agreement with the county recorder. It may produce results at some future time, but it carries so many risks that you may decide it isn’t worth it.
Here’s how it works. Your preliminary agreement includes a clause in which the seller authorizes you to record it in the county where the mortgage or deed of trust is recorded. (The mortgage or deed of trust is the document recorded against the real estate that secures the note.) You record the agreement and let time pass.
The agreement usually shows up on any future title report, where it can be a cloud on the title. A seller who backed out then becomes eager to remove that cloud, because a pending transaction usually depends on it. At that point you can negotiate a settlement for releasing the agreement.
There are many ways this plan can backfire:
- The county recorder may refuse to record an unusual document like an agreement to sell a note.
- If the recorder accepts it, it must contain the legal description of the real estate securing the note, a detail you must not forget.
- Recorders normally accept only notarized documents, and your seller may not agree to have the agreement notarized.
- The title insurance company may decide your agreement concerns the paper, not the real estate itself, and insure the title anyway, which defeats your purpose.
The worst backfire comes from the note payor, the owner of the property. If your recorded agreement interferes with a transaction (buying the note, selling or refinancing the property), the payor may be angry that you got permission to record only from the note seller. You could face a lawsuit for slander of title unless you release the agreement immediately, and you may owe the payor damages.
Recording your agreement may produce a settlement in a few cases, but the risks are generally not worth taking.
Never hold the seller’s property hostage
There are two steps note buyers might think of but must never take:
- Refusing to return an original note to a seller who has backed out and asks for it back. If you haven’t paid for it, you are holding someone else’s property hostage.
- Getting the seller’s notarized signature on an Assignment of Mortgage or Assignment of Deed of Trust and recording it before the transaction is complete. This amounts to the same thing.
You could face severe legal penalties for either act, which could be considered conversion: “any unauthorized act which deprives an owner of his property permanently or for an indefinite time.” This could get you into serious trouble.
Why moving on is usually the best remedy
As you can see, there is no magic solution. Every remedy has its drawbacks. There may be some situations in which you would want to sue or force a settlement, but the experience will be interesting, expensive and a drain on your attention.
The wisest and most practical choice in most situations is to forget it and go on to the next deal. Put your effort into the positive. You’ll feel better, and you’ll do better.
